What matters: An investing evolution

Senior Analyst James Greenhalgh is moving on. Here, he explains how his investment approach has developed over a decade, and what you might learn from it.

One way or another, I’ve been associated with Intelligent Investor for about 12 years now. It’s a special place to work, with a shrewd bunch of investors who think very differently from the mainstream investment community.

My views on many topics, indeed my entire approach to investing, has evolved over that time. Perhaps the most glorious thing about getting older is that I realise how little I knew when I was young.

Some beliefs have remained more or less unchanged, others have formed but more still have been turned upside down. I hope this list of ten things I’ve learned stimulates your synapses. For what it’s worth, here’s what I think matters:

1. Portfolio weightings matter: I’m now far more convinced that sensible capital allocation is essential. Evaluate how risky a business is and allocate capital accordingly; speculative stocks should be limited to 2-3% each. Conversely, when a high quality business you own becomes very cheap, buy more. Diversification is important, none of us are Warren Buffett so we shouldn’t be making 25% bets.

2. Patience matters: Over the years, I’ve trained myself to make fewer but better decisions. Please excuse the tedious baseball terminology but this means waiting for the ‘fat pitches’ - the best of the best opportunities. Try to avoid being distracted by mediocre companies at reasonable prices; wait for standout companies at bargain prices. Two or three a year might be all you need to build a decent portfolio over time.

3. Quality matters: In the past, I’ve done well buying small, cyclical stocks when they were very out of favour. Now I wonder whether it was the bull market that saved me. These stocks have generally gone from bad to worse in the period since the global financial crisis. Instead, the businesses that have held up best have been my quality holdings — big, well-managed companies with solid balance sheets. Make these the backbone of your portfolio.

4. Management matters: There was a time when I thought management almost irrelevant. Buying a mispriced stock was far more important. Having seen what happened at funds management company Perpetual over the past decade, I now think management — and in particular management changes — need careful consideration. As I now prefer to own businesses for a long period, management’s capital allocation ability needs to be taken into account.

5. Price paid matters: Past mistakes such as Sigma Pharmaceuticals made me question whether I was overpaying for quality. I’ve sometimes struggled with the idea of paying for quality in my own portfolio, which is perhaps why it often contains a smattering of cheap cyclicals. Now I think you should pay up for quality, but not by too much. Mr Market provides infrequent opportunities to buy good businesses at reasonably cheap prices (see Patience Matters above) and they’re really all you need.

6. Big winners matter: I might instead say ‘Don’t sell quality companies too soon’. This is one of the biggest and easiest mistakes to make. Deeply underpriced high quality companies are rare, so don’t let them go just because the share price has risen. Let time work its compounding magic. When your broker says ‘you never go broke taking a profit’, tell him, ‘Well, you don’t get rich taking a profit, either’.

7. Free cash flow matters: I’m ashamed to admit that, long ago, I used to give the cash flow statement only a cursory glance. Now it’s the first financial statement I turn to. If a company isn’t producing reasonable free cash flow, then it’s very unlikely to enter my investment universe. Asset-heavy businesses that require a lot of capital expenditure rarely produce much cash for shareholders. Narrow down your search by excluding them entirely.

8. The seller matters: Or, ‘Don’t buy anything from private equity’. In the 1990s, before the private equity boom, I did well buying company floats. Unfortunately, I tended to sell them too soon because I was less aware of point 6. Those days are gone; a large proportion of new floats are debt-laden, hollowed out shells, sucked dry by their private equity owners. Having avoided the Myer and, unfortunately, failed to avoid the Collins Foods floats, you’ll generally be well served by ignoring most private equity offerings.

9. Macroeconomics matters: In the past, I’ve followed Peter Lynch’s maxim that ‘If you spend 13 minutes a year on economics, you’ve wasted 10 minutes’. In context, his assertion was that economic forecasts are useless, but what the period since the global financial crisis has shown is that economic issues are important. You should be thinking about inflation, the housing market, the Aussie dollar, the sustainability of the euro, and numerous other risks. Otherwise, you could expose your portfolio to wipe-out events (such as bank collapses or runaway inflation).

10. Life matters: It’s easy to become despondent when your portfolio is performing poorly. But never forget that your partner, your family, your health and your friends are more important than anything else. Work and investing is only ever a small part of your life, so don’t neglect the rest. Take time to stop and smell the magnolias [that’s James being as contrarian as ever—Ed].

So that’s what I’m doing. After 12 years, it’s time for a break and a re-evaluation of life’s priorities. I’ll never stop being an investor, but there are other things in life, too.

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